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Theme 4: Reforming the global financial architecture

An International Insolvency Framework - Why it is needed and what it could look like

1. Between 1999 and 2005 substantial progress has been achieved in terms of debt relief for developing countries. Through a combination of partial debt relief and strong economic growth key indicators could be considerably reduced in several countries. In a few Non-HIPC countries individually designed debt relief also led to considerable improvements.

2. During this process the international community failed, however, to develop debt management as such any further. The HIPC and MDRI relief schemes have been deliberately designed as one-off exercises. Thus, a newly over-indebted developing country would face today the same problems, which countries had after the crisis’ outbreak in 1982: there exists no comprehensive mechanism to reduce a country’s exposure to all its creditors in an orderly and pre-defined way.

3. Thus a HIPC, which has gone through the debt relief process has no mechanism or procedure to refer to, once it runs into new payment problems. Even before the global financial crisis took effect on the poorest countries, the World Bank acknowledged in its latest status of implementation report a "high risk of new debt distress" in 4 countries and a "moderate" one in an additional 10. It must be assumed that the situation has already turned more critical for more countries since the report’s publication, and will continue to do so during 2009.

4. Additionally to Post-completion point HIPCs, which run into new debt distress, it must be assumed that some non-HIPCs will either run into over-indebtedness as a result of emergency financing, or that countries which never really managed to get out of the debt crisis of the 1980s and 1990s will be pushed over the edge by the global economic slowdown.

5. At the same time the spectrum of creditors and the variety of instruments these creditors use, has considerably widened in the past years. Some transformation and emerging economies have become important lenders themselves. So have private investment funds and domestic lenders. New debt results from some new types of bonds, from the return of the classic syndicated by commercial banks, and also from a new wave of aggressive marketing by Export Credit Agencies.

6. The International Financial Institutions (IFIs) have tried to steer this new borrowing through the World Bank’s debt Sustainability Framework (DSF). These efforts are not likely to be successful, because they unilaterally exert pressure on the borrower, without providing much of an incentive for the creditor to forego an investment opportunity, because it would eventually endanger the borrower’s long-term debt sustainability. Individual instruments like Collective Action Clauses (CACs) or Codes of Conduct can be useful at times. However, they generally refer to not more than one group of lending instruments or creditors.

7. With this lack of debt workout options there is an extreme danger that in both, low and middle income countries, a new round of defensive lending by multilateral institutions will start a new debt cycle like the one of the 1990’s. The present emergency packages by the IMF and their co-financing from other multilateral institutions may be considered as being without alternative. However, it must be remembered that debt owed to multilateral institutions was negligible at the beginning of the 1980ies debt crisis. It became an ultimately costly exercise for the international community and a burden on development aid budgets through a long period of defensive lending. A clear-cut debt write-off in the end-1980s would have been less costly for everybody.

8. Against this background the Doha process confirmed the Monterrey Consensus’ call for new orderly debt workout mechanisms. Proposals mentioned in Doha include the IMF’s Sovereign Debt Restructuring Mechanism and also farther reaching proposals by academia, civil society and Southern officials. Most of these proposals convene under an "International Insolvency Framework"